Beyond past performance: Key factors for mutual fund selection

Choosing the right mutual fund to invest in can be daunting, given the countless options available in the market today. While the fund's past performance—some numbers on what kind of returns it has offered in the recent past—may seem to be an obvious starting point for your investigation, this may not be an accurate indicator of the fund’s performance in the days to come.

In the latest episode of Mint Money Shots, presented by Invesco Mutual Fund, Deputy Editor at Mint, Neil Borate delved into why relying solely on past performance might not be the best strategy for your investments. “Have you ever heard the phrase: ‘Past performance is not indicative of future results?’. Well, when it comes to mutual funds, this couldn’t be more true,” said Borate as he opened the video.

“Some intermediaries rely on past returns to give recommendations to clients. However, research shows that only 1 of the top 5 top-performing funds continue to excel over the next five years. Shocking number right, a mere 20 per cent success rate,” he further said. Watch the full episode here,

Then, what should one be looking for in this complex world of investing, specifically mutual funds? Read on to know more.

1. Portfolio construction

First, you must clearly define your investment goals – what are you investing for? Is it savings for retirement, a child’s education, or a down payment for a new home you wish to buy? Then, see how the fund you have selected fits in with meeting your goals. You must remember that diversification is a very important aspect that you need to look into. A well-constructed portfolio spreads your investment across different sectors or asset classes, thereby reducing risk and enhancing returns.

2. Fund management strategy

“A strong, adaptable management strategy is crucial. It’s about how well the fund can navigate changing market conditions,” said Borate. When you are selecting the right mutual fund, look for a fund manager with a proven track record of adapting to different market cycles and making sound investment decisions when there is a change in order. Their ability to identify opportunities and mitigate risks is essential for long-term success. Understanding how a particular fund manager selects securities and constructs the portfolio can provide valuable insights into the fund’s potential returns and risks.

3. Fund manager’s track record

The expertise and experience of the fund manager play a significant role in the kind of returns an investment offers. A skilled manager can make a big difference in a fund’s performance, and therefore, you must ask for the past performance and investment strategy of the fund you wish to put your money into. Selecting a fund with a long-standing fund manager who has displayed a track record of consistent returns is a good option.

4. Global macro trends

Understanding the larger economic landscape is also crucial to mutual fund selection. Global macro trends like changes in interest rates, geopolitical events, and economic cycles can significantly impact the performance of any investment. “If you are choosing sectoral funds, check how global macro trends within the sector are shaping up,” Borate said.

5. Keep biases at bay

Overconfidence, aversion to taking risks, or following a herd mentality to pick ‘popular’ funds are common biases among investors today. “We all have our biases. Being conscious about our own behavioural biases can help us make a rational investment decision when selecting funds,” said Borate.

In conclusion

Selecting the right mutual fund is a critical step in building a robust investment portfolio. “So, should you or your advisor rely on the past performance of mutual funds given just a 20 per cent success rate? The answer is NO. Instead, take a holistic approach by evaluating fund management strategy, fund manager track record, portfolio construction and others. The next time, when you are selecting a mutual fund, remember, it’s not just where it has been, but where it is headed,” said Borate.

(This article is part of Mint's video series Money Shots, sponsored by Invesco Mutual Fund)